Dr Chan: Play Conservatively As Correction May Resume

The US stock market corrected after rising for nine consecutive days recently. On 20 September, the US Federal Reserve (Fed) decided to keep interest unchanged, but will begin the process of shrinking its balance sheet in October 2017. For a start, the Fed will reduce its purchases of securities by US$10 billion a month, reviewing the quantum every quarter until it ratchets up the volume to US$50 billion a month next year.

In addition, the Fed guided to more interest rate hikes in 2018 and 2019. Of course, that would depend on whether Janet Yellen – who was appointed by Obama – gets reappointed as the Fed’s chairwoman. For now, markets are still uncertain if Yellen has earned enough of Trump’s trust to seek reappointment. As a result, the US market immediately declined upon the Fed’s announcement.

Following the correction, US stocks also quickly rebounded to record a nine-day winning streak as the underlying catalyst for US stocks still persists. What then could explain the correction that came on 21 September?

Some analysts have attributed it to Trump’s strengthening of economic sanctions on North Korea while others thought it could be due to North Korea Vice Foreign Minister’s warning of an atomic bomb test in Asia Pacific.

But tracing back to 15 September, US stocks did not decline in spite of the missile North Korea launched across Japan’s airspace and some 3,700 kilometers into the Pacific Ocean. In fact, it was only four days after the last missile test that US stocks fell. Seemingly, the market is increasingly becoming unconcerned about the tensions in the Korean peninsula.

What is more worrying though, is the prospect of more interest rate hikes. In the past, the stock market climbed in the initial stages of interest rate hikes as levels were still accommodative enough for corporations to refinance and invest. However, it would reach a tipping point when financing becomes too expensive and eventually crumble the stock market.

Going forward into 2018, how interest rates move will ultimately depend on President Trump’s plans, which at this point are still uncertain. After the Fed’s meeting on 20 September, the US dollar began appreciating across the board and bank stocks also rose on the expectation that wider interest rate spreads would improve profitability. The ongoing dynamics clearly reflected the importance the stock market has placed on the interest rate outlook.

That said, interest rates are still at an accommodative range even after the factoring in the remaining interest rate hike this year and hence will not create significant downward pressure to the stock market. On the contrary, the Fed’s decision reflected its confidence towards the US economy and an accelerating economy will lift US corporate earnings and its stock market.

But fear will eventually begin to set in. What level of interest rates will signal a turn in sentiments? There is really no benchmark and would depend on what triggers the panic.

Of course, how quick and how much the panic-selling would depend on the amount of speculation. In speculative periods, experienced investors and speculators would be nimble enough to plan their exits. Like a game of musical chair, everyone will be rushing for the last seat out of the fray when the music ends.

At the moment, pressure on the Singapore and Hong Kong stock markets is not coming from interest rate fears but rather due to the weakness of China A-shares. The Shanghai Composite Index (SHCOMP) has been trading sideways for a while since rising to 3,300 points.

Back in 2015, the China stock bubble burst after its “Golden Rally”. Many state-owned financial institutions had to buy up securities in the SSC, in order to support the index at between 3,300 to 3,500 points, and hence accumulated significant paper losses.

Presently, these deep-pocketed financial institutions are selling away their shareholdings, putting a lid on Chinese stocks. However, investors need not worry about an impending plunge because deep-pocketed financial institutions have holding power and will only sell at reasonable prices. As such, investors in Chinese stocks must wait patiently for these institutions to unwind their positions before the Chinese stock market can climb again.

Recently, US Wisconsin Governor signed into law a US$3-billion tax subsidy package for Foxconn Technology Group (Foxconn), a Taiwanese corporation. This was a groundbreaking deal in high-tax America that tended to see funds flow overseas for investments. This time round, the US is attracting overseas funds to its shore through tax incentives. In exchange, Foxconn has agreed to invest US$10 billion to build a flat-screen factory in the state of Wisconsin.

Tax reform is one of Trump’s top campaign priorities and the US has successfully taken the first step. The next step is to completely reform the tax code by means of cutting taxes to attract investments.

Tax-cuts have long been criticized by the left-wing and liberal economists as a policy that favours the rich. When Trump made known of his tax reform plan, many economists also accused the US government of intervening in America’s laissez faire system.

The government’s role in the market has long been a widely debated topic. After all, many countries have also succeeded in boosting their economies through measured interventions. Theoretically, this means limited interventions could work as a better system than a free market.

For example, 52 years ago when Singapore gained independence, the government immediately introduced tax incentive policies to attract foreign investments to build factories and create jobs. Through it, Singapore’s economy took off and we also benefitted from the technology we acquired. Unlike US, Singapore’s government officials have the discretion to decide which enterprises can receive tax incentives while the former requires both the US congress to vote and the state governor to sign off.

Adding on, China also managed to boost its economy through tax incentives ever since it opened up its economy. Many emerging markets also followed suit to attract foreign investment and quickly transformed into industrialised economies.

With the US government taking an interventionistic approach, it is becoming evident that measured interventions can be more effective. That said, Singapore will be facing strong competition from the US when it introduces tax cuts as well.

A mini rout finally ensued recently, as investors rushed to reduce their positions and lock in profits amidst a 20 percent correction. Even if the underlying trend is still bullish, investors should not return to load up as prices are still unattractive despite the recent correction.

Notwithstanding that, US tech stocks are also falling in big magnitude. Investors in local tech stocks should also be wary of the negative sentiments spilling over. In such a time, it is best to play conservatively.